1. Managing Business Process Flows: Ch 6 Supply Chain Management
Chapter 6
Managing the Supply Chain
Key to matching demand with supply
Managing materials waiting time
Cost and Benefits of inventory
Inventory Analysis: Economies of Scale (Ch 6)
Palu Gear: Inventory management of a retailer: EOQ + ROP
Levers for improvement
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2. Key Financial Indicators of Supply Chain Performance
Chapter 6
Key Financial Indicators of Supply Chain Performance
Return on Assets
Net Present Value …
These are LAGGING indicators. What must the supply chain do to achieve this?
Notes:
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3. Accurately Matching Demand with Supply is the Key Challenge: Inventories
Chapter 6
2008 Logistics costs (US economy)
Freight Transportation $864Billion
Inventory Expense $420 Billion
Administrative Expense $60 Billion
Logistics related activity 9.4% of GDP
Inventory = Working capital
Reduced inventory implies less working capital
Why do inventories arise?
Mismatch between demand and supply
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4. Costs of not Matching Supply and Demand
Chapter 6
Costs of not Matching Supply and Demand
Cost of overstocking
liquidation, obsolescence, holding
Cost of under-stocking
lost sales and resulting lost margin
Notes:
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5. Where is the Flow Time? Operation Buffer Waiting Processing Notes:
Chapter 6
Operation
Buffer
Notes:
Waiting
Processing
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6. Flow Times in White Collar Processes Source: J. Blackburn
Chapter 6
Flow Times in White Collar Processes Source: J. Blackburn
Notes:
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7. Flow time T = Inventory I / Throughput R
Operational Flows
Chapter 6
Throughput R
Inventory I
FLOW TIME T
Notes:
I = R T
Flow time T = Inventory I / Throughput R
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8. Why do Buffers Build? Why hold Inventory?
Chapter 6
Economies of scale
Fixed costs associated with batches
Quantity discounts
Trade Promotions
Uncertainty
Information Uncertainty
Supply/demand uncertainty
Seasonal Variability
Strategic
Flooding, availability
Cycle/Batch stock
Safety stock
Notes:
Seasonal stock
Strategic stock
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9. Cost of Inventory Holding cost Physical holding cost (out-of-pocket)
Chapter 6
Cost of Inventory
Physical holding cost
(out-of-pocket)
Financial holding cost
(opportunity cost)
Low responsiveness
to demand/market changes
to supply/quality changes
Holding cost
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10. Palü Gear: Retail Inventory Management & Economies of Scale
Annual jacket revenues at a Palü Gear retail store are roughly $1M. Palü jackets sell at an average retail price of $325, which represents a mark-up of 30% above what Palü Gear paid its manufacturer. Being a profit center, each store made its own inventory decisions and was supplied directly from the manufacturer by truck. A shipment up to a full truck load, which was about 1500 jackets, was charged a flat fee of $2,200. To exploit economies of scale, stores typically ordered full truck loads. (Palü’s cost of capital is approximately 20%.)
What order size would you recommend for a Palü store in current supply network?
The Palu Gear case, authored by J. Van Mieghem and available from is used to teach both EOQ and safety stock, newsboy, and centralization. [There also is a version that is focused on periodic review].
retailer
manufacturer
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J.A. Van Mieghem/Operations/Supply Chain Mgt

11. Economies of Scale: Inventory Build-Up Diagram
R: Annual demand rate,
Q: Number of wind breakers per replenishment order
Number of orders per year = R/Q.
Average number of wind breakers in inventory = Q/2 .
Inventory
Inventory Profile:
# of wind breakers in
inventory over time. Q
-R = Demand
rate
Q/2
“cycle stock”
Time t
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J.A. Van Mieghem/Operations/Supply Chain Mgt

12. Palü Gear: evaluation of current policy of ordering 1500 units each time
What is average inventory I?
I =
Annual cost to hold one unit H =
Annual cost to hold I =
How often do we order?
Annual throughput R =
# of orders per year =
Annual order cost =
What is total cost?
TC =
What happens if order size changes?
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13. Find most economical order quantity:
Find most economical order quantity: Spreadsheet for a Palü Gear retailer
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J.A. Van Mieghem/Operations/Supply Chain Mgt

14. Accurate Response to Scale Economies: Economic Order Quantity EOQ
Total annual costs
H Q/2: Annual holding cost
S R /Q:Annual setup cost
Order Size Q
Fixed cost per order
The order quantity that minimizes total supply chain cost is:
Annual unit demand
Annual unit holding cost
Copyright © 2013 Pearson Education Inc. publishing as Prentice Hall
J.A. Van Mieghem/Operations/Supply Chain Mgt

15. Optimal Economies of Scale: For a Palü Gear retailer
R = 3077 units/ year = 59 units/wk C = $ 250 / unit
r = 0.20/year S = $ 2,200 / order
Unit annual holding cost = H = 0.20/yr x $250 = $50/yr
Optimal order quantity = Q = sqrt(2 x 3077 x 2200/50) = 520
Number of orders per year = R/Q = 5.9
Time between orders = Q/R = 0.17yr = 8.8weeks
Annual order cost = (R/Q)S = $13,008.87/yr
Average inventory I = Q/2 = 260
Annual holding cost = (Q/2)H =$13,008.87/yr
Average flow time T = I/R = yr = 4.4weeks
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J.A. Van Mieghem/Operations/Supply Chain Mgt

16. Costs associated with batches
Order Costs (S)
Setup/Changeover of process
Transportation
Receiving
Holding costs (H)
Physical holding cost
Cost of capital
Cost of obsolescence
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17. Optimal Economies of Scale: Managerial Insights
How cut inventories (economically smart)?
Budgeting for growth
Last FY: Sales = $100M Inventories = $20M
Next year: Sales = $200M Inventories = ?
Days-of-inventory:
Centralized inventory management
Copyright © 2013 Pearson Education Inc. publishing as Prentice Hall
J.A. Van Mieghem/Operations/Supply Chain Mgt

18. Learning Objectives: Batching & Economies of Scale
Increasing batch size Q of order (or production) increases average inventories (and thus flow times).
Average inventory for a batch size of Q is Q/2.
The optimal batch size minimizes supply chain costs by trading off setup cost and holding cost and is given by the EOQ formula.
To reduce batch size, one must reduce setup cost (time).
Economies of scale are manifested by the square-root relationship between QEOQ and (R, S):
If demand increases by a factor of 4, it is optimal to increase batch size by a factor of 2 and produce (order) twice as often.
To reduce batch size by a factor of 2, setup cost has to be reduced by a factor of 4.
Copyright © 2013 Pearson Education Inc. publishing as Prentice Hall
J.A. Van Mieghem/Operations/Supply Chain Mgt

19. Role of Leadtime L: Palü Gear cont.
The lead time from when a Palü Gear retailer places an order to when the order is received is two weeks. If demand is stable as before, when should the retailer place an order?
Inventory Profile:
Two key decisions in inventory management are:
How much to order?
When to order?
Inventory Q -R
Time t
Copyright © 2013 Pearson Education Inc. publishing as Prentice Hall
J.A. Van Mieghem/Operations/Supply Chain Mgt

20. Continuous Review Policy: Ordering Decisions and the Re-order Point
ROP L -R
Place
order n
I(t) Q
time
Receive
order n+1
order n+2
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21. ROP and Inventory position
ROP = L × R
But if lead time L is greater than time between orders, there will be more than one order outstanding
Inventory position = Inventory level (On-hand inventory) + On-order inventory
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22. Order Policies
Continuous Review: Ability to monitor inventory continuously and take action
Order fixed quantity whenever inventory position reaches re-order point
Periodic Review: Monitor inventory periodically and take action
Order sufficient quantities at periodic intervals (e.g., every Monday) to raise inventory position to a target level (order up to level or OUL),
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23. Inventory Profile for a Periodic Review Policy: Example Ch 63 1
Q=1200 units
OUL = 1800 2
1200 units
Recd.
Review Period Tr=2
Order
Placed
L=1 week
600 units 4
Inventory Position
On-hand inventory
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24. Periodic Review: Palu Gear
OUL = (L+Tr) × R
Suppose Palu Gear placed orders 4 weeks; then Tr = 4 weeks
With L = 2 weeks,
OUL = (4+2) x 59 = 354 units.
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25. Learning Objectives: Batching & Economies of Scale
Chapter 6
Increasing batch size of production (or purchase) increases average inventories (and thus cycle times).
Average inventory for a batch size of Q is Q/2.
The optimal batch size trades off setup cost and holding cost.
To reduce batch size, one has to reduce setup cost (time).
Square-root relationship between Q and (R, S):
If demand increases by a factor of 4, it is optimal to increase batch size by a factor of 2 and produce (order) twice as often.
To reduce batch size by a factor of 2, setup cost has to be reduced by a factor of 4.
Continuous vs. Periodic Review
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Printed in the United States of America.
Copyright © 2013 Pearson Education Inc. publishing as Prentice Hall